## _sdn1208rev - Executive Summary ## Source details **Canonical URL:** [_sdn1208rev - Executive Summary](https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/ft/sdn/2012/_sdn1208rev.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-publications/external/pubs/ft/sdn/2012/_sdn1208rev.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-publications/external/pubs/ft/sdn/2012/_sdn1208rev.pdf.json) --- ### Key findings on income inequality trends - Income inequality has increased in most advanced and many developing economies over recent decades, reflecting factors including globalization and technological change. - Large variation exists in average disposable (post-tax-and-transfer) income inequality across regions, much of which can be accounted for by differences in the level and progressivity of tax and spending policies. - Between 1990 and 2005, average inequality in each region changed by less than 4.5 percentage points. - Regional averages in 1990–2005: - The two most unequal regions (Sub-Saharan Africa and Latin America) had average Gini coefficients that exceeded 0.45 every year. - The two most equal regions (emerging Europe and advanced economies) had average Gini coefficients less than 0.34, a difference of 11 percentage points. - Over the last three decades, pre-tax-and-transfer (market income) shares of the richest increased substantially in English-speaking advanced economies, India, and China, but much less in Southern European and Nordic economies, and hardly at all in continental Europe and Japan. - United States specific figures: - Share of market income captured by the richest 10 percent rose from around 30 percent in 1980 to 48 percent by 2008. - Share of the richest 1 percent increased from 8 percent to 18 percent. - Share of the richest 0.1 percent increased from 2.6 percent to 10.4 percent. - The international dataset assembled covers 22 advanced and 128 developing economies. ### Fiscal policy’s redistributive role: overall assessment - Fiscal policy influences income distribution directly (current disposable incomes) and indirectly (future earnings capacities affecting market incomes). - There is a trade-off: redistributive tax-benefit systems can introduce economic inefficiencies as behavioral responses reduce the overall size of the income pool being redistributed. The efficiency cost of redistribution typically increases with the extent of redistribution. - The note focuses on the actual (observed) redistributive impact of fiscal policy (statutory incidence, as commonly used in the literature), recognizing that actual incidence can differ from statutory incidence. ### Advanced economies: evidence on redistribution - Fiscal policy has played a significant role in reducing income inequality in advanced economies, especially where pre-tax-and-transfer inequality was high. - Between 1985 and 2005, fiscal policy (direct income taxes and transfers) decreased the average Gini in 25 OECD countries by about one-third, that is, by around 15 percentage points. - 2005 examples: - Fiscal policy reduced income inequality by around 20 or more points in: Belgium, Denmark, Germany, Italy, Luxembourg, Poland, and the Slovak Republic. - Fiscal policy reduced income inequality by less than 10 points in: Korea, Iceland, Ireland, Switzerland, and the United States. - Composition of redistribution: - On average, redistribution achieved by public cash transfers is twice as large as that achieved through taxes. - Non-means-tested transfers (including public pensions and universal child benefits) account for the bulk of redistribution on the expenditure side; particularly important in Nordic economies, Austria, Belgium, Poland, and Hungary. - Income taxes achieve the greatest amount of redistribution on the tax side; in most economies, income taxes redistribute more than means-tested transfers. - United Kingdom and Ireland are exceptions where means-tested benefits are responsible for most of redistribution. - United States is an exception where taxes are more redistributive than transfers and where the income tax system plays a relatively strong role in redistributing towards low-income families. - Redistributive impact has declined since the mid-1990s: - Between the mid-1980s and mid-1990s, the Gini for market income increased by 3 percentage points, while the Gini for disposable income increased by only 0.8 points—implying offsetting fiscal redistribution increased in that earlier period. - Reforms since the mid-1990s have lessened the generosity of social benefits and the progressivity of income tax systems in advanced economies, making fiscal policy less redistributive. - Redistributive impact over time: - Fiscal policy offset 73 percent of the 3 percentage-point increase in market income inequality between the mid-1980s and mid-1990s. - Between the mid-1980s and the mid-2000s, fiscal policy offset 53 percent of the increase in market income inequality. - Market income inequality grew by twice as much as redistribution over the two decades from the mid-1980s to the mid-2000s. - The fall in redistributive impact reflected reforms that reduced the overall progressivity of the tax-benefit system, including reductions in the generosity of social benefits (particularly unemployment and social assistance) and reductions in income tax rates, especially at higher income levels (OECD, 2011a). ### Fiscal design and the equity-efficiency trade-off - Key points: - Means-tested social benefits (benefits withdrawn as earnings increase) create disincentives for low-skilled workers to take up employment (OECD, 2011b). - Immervoll and others (2007) find that transferring an additional euro from high- to low-income individuals through traditional means-tested transfer programs results in a reduction in the welfare of high-income individuals by 2 to 4 euros in most economies. - Policy responses to reduce disincentives: - Introduction of in-kind benefits that link receipt of benefits to employment. - Expansion of active labor market programs and tightening rules for continued eligibility for unemployment benefits (more intensive job search requirements and participation in training). - Note: Designing and implementing these policies requires substantial administrative capacity. - On progressive income tax schedules: - Reductions in top income tax rates in many economies during the 1980s were followed by relatively high income growth at the top of the income distribution (Saez, 2004; Atkinson and Leigh, 2010; Roine, Vlachos, and Waldenstrom, 2009). - Countervailing research (Piketty, Saez, and Stantcheva, 2011) argues that the absence of any correlation between rising top incomes and per capita GDP growth indicates top income increases primarily reflect rent-seeking rather than productivity increases, motivating calls for more progressive taxation of higher income groups (Tanzi, 2011). - Need to remove opportunities for tax evasion and avoidance, which are typically greater for higher income groups, to preserve revenue potential and redistributive impact (Gruber and Saez, 2002). ### Indirect taxes and in-kind transfers - Indirect taxes: - In an analysis of 12 European Union economies, the effective indirect tax rate (share of consumption taxes in total household income) is on average three times higher for the bottom income decile than for the top decile (O’Donoaghue, Baldini and Mantovani, 2004). - Both the value-added tax (VAT) and excise duties are regressive in all economies; excise taxes are especially regressive, their share in total income being four times higher in the bottom income decile than in the top income decile. - In-kind transfers: - A high share of public spending is allocated to education, health care, housing, and food transfers. - Each component tends to reduce inequality: public housing benefits target low-income households; public education and health services are disproportionately used by households with children and elderly concentrated in lower parts of the disposable income distribution. - On average, in-kind transfers decreased the Gini coefficient by 5.8 percentage points in five European economies (Belgium, Germany, Greece, Italy, and the United Kingdom), with health accounting for 3.6 points and education for 2.2 points of this impact (Paulus, Sutherland, and Tsakloglou, 2009). ### Corporate tax incidence - Few incidence studies include corporate income taxes due to difficulty in establishing incidence. - Long-run incidence depends on relative mobility of capital and labor and the size of the home country in affecting the international rate of return on capital (Auerbach, 2006). - Taxation of rents (above normal profits) is likely to fall on owners of capital. - Recent empirical evidence suggests that between 45 and 75 percent of the corporate tax burden falls on wages (Gentry, 2007; Arulampalam, Devereux and Maffini, 2010). - Since wage earners typically have lower mean incomes than those with capital income, corporate income taxes may not be as progressive as they first appear; progressivity could be higher if low-skilled labor is a good substitute for capital. ### Developing economies: fiscal capacity and constraints - Redistributive impact of fiscal policy in developing economies is relatively low due to lower overall levels of taxes and transfers. - Average tax ratios: - Advanced economies: exceed 30 percent of GDP. - Developing economies (excluding emerging Europe): generally fall in the range 15–20 percent of GDP. - Spending is substantially lower in developing economies, especially in Asia and the Pacific and in Sub-Saharan Africa; low transfer spending explains most of the difference. - This substantially reduces the redistributive potential of fiscal policy in developing economies. - Enhancing distributive impact in developing economies requires improving capacity to raise tax revenues and to spend those resources more efficiently and equitably. ### Crisis and post-crisis distributional dynamics - No uniform pattern in distributional changes following the 2007–2008 financial crisis; effects varied across countries and over time: - Ireland: inequality initially declined early in the crisis due to a large fall in top incomes, increases in taxes, and expansion of redistributive social transfers; as the crisis deepened and fiscal consolidation intensified, inequality began to increase, with the Gini increasing by nearly 2 percentage points by end-2010. - Italy: Gini increased by 1 percentage point initially, then showed a decrease as the crisis evolved. - Other heterogeneous outcomes: Gini increased in Latvia and Lithuania but fell in Estonia, Greece, and Iceland; Gini increased in France and Spain but fell in Portugal and the Netherlands. - United States: Gini changed little during the crisis as expansion of public transfers offset high unemployment’s inequality impact. - Distributional effects of crises can take many years to fully materialize. ### Policy recommendations for distributive fiscal strategies (especially under fiscal consolidation) - In the context of fiscal consolidation, tax and spending measures should enhance or maintain the distributive effects of fiscal policy while supporting economic efficiency. Suggested measures include: - Reducing opportunities for tax evasion and avoidance. - Increasing the progressivity of income taxes over higher income brackets. - Cutting unproductive expenditures. - Expanding means-tested programs. - For developing economies, resource mobilization and expenditure reforms should focus on: - Broadening income and consumption tax bases. - Expanding corporate and personal income taxes by reducing tax exemptions and improving compliance. - Reducing universal price subsidies. - Improving capacity to implement better-targeted transfers. - Gradually expanding social insurance systems. - Short- and medium-term strategy for advanced economies undergoing consolidation: - Short term: protect the most redistributive social benefits (including unemployment benefits) until recovery and unemployment decline; expand active labor market programs. - Medium term: rely somewhat more on tax measures and broaden coverage of expenditure reforms (military spending, subsidies) to avoid large cuts in redistributive transfers. - Policy options to preserve equity while consolidating: - Greater reliance on progressive revenue measures where feasible. - Removing opportunities for tax avoidance and evasion. - Greater reliance on progressive wealth and property taxes. - Broadening expenditure reforms (military spending, subsidies, public-sector wages). - Expanding active labor market programs (job-search support, targeted wage subsidies, training). ### Box 1. Fiscal Policy and Income Inequality in Latin America — key points - Fiscal policy effectiveness: key findings - In the mid-2000s, the tax and transfer system decreased the average Gini in six Latin American economies (Argentina, Brazil, Chile, Colombia, Mexico, and Peru) by only about 2 percentage points, from 0.52 to 0.50. - Similar magnitudes are reported by Lustig and others (2011) using more recent data. - By contrast, in 15 European economies the tax and transfer system decreased the Gini by around 20 percentage points, from 0.46 to 0.27. - Almost three-quarters of the difference in the Ginis for disposable income between these Latin America and European countries (18 out of the 23 points) can be explained by different fiscal policies. - Reasons for limited redistributive impact in Latin America: - Tax collections in the region are below the levels achieved in economies with similar levels of income, with the median being 4 percentage points lower. - Recent increases in the tax-to-GDP ratio have relied more on regressive indirect taxes and a decreasing share of more progressive income taxation. - The low tax ratio reflects narrow tax bases (due to tax evasion, numerous loopholes, a large informal sector and weak tax administrations) rather than low tax rates. - The six Latin American economies above spend 7.6 percent of GDP on social transfers compared to 16.3 percent in the 15 European economies. - In Latin America, the richest 40 percent of the income distribution capture over 70 percent of social spending, whereas social spending in Europe is distributed evenly across the income distribution. - Conditional cash transfer (CCT) programs: - 17 Latin American economies are currently operating conditional cash transfer programs, with program expenditures typically falling below 1 percent of GDP. - The largest programs, in Brazil and Mexico, have been estimated to reduce the Gini for disposable income by 2.7 percentage points, accounting for about a fifth of the decrease in the Gini coefficient between the mid-1990s and the mid-2000s. - CCTs are most cost-effective when targeted at the poorest households; expansions must be designed to generate human capital impacts and avoid labor supply disincentives. - Fiscal consolidation and inequality: mechanisms - Short-run macroeconomic channel: consolidation reduces output and increases unemployment in the short run, typically associated with a declining wage share, which tends to increase inequality. - Policy composition channel: income inequality will tend to increase more when adjustment relies on increasing regressive taxes (such as consumption taxes) or cut-backs in progressive spending. - Definition of a large fiscal consolidation: Lasts at least three years, where the cyclically adjusted primary balance (CAPB) improves by at least 5 percent of GDP, and where the cumulative change in the CAPB is not reversed by more than 1 percentage point from one year to the next. - Advanced economies: evidence and policy lessons - Episodes of large fiscal adjustment in advanced economies have been associated with sizeable increases in unemployment in the short term. - Adjustments biased toward expenditure cuts have tended to exacerbate income inequality. - Protecting progressive social benefits and improving targeting can minimize adverse distributional impacts (illustrated by Denmark, Germany, Iceland, Sweden). - Developing economies: evidence and policy lessons - Consolidation can be essential to reduce high inflation, which typically has adverse effects on inequality. - Consolidation effects can improve equity if expenditure reductions are concentrated in non-progressive spending and social safety nets are strengthened. - Summary conclusions and policy recommendations (Box 1): - Historical role of fiscal policy: combination of progressive income taxes and redistributive transfers decreased inequality by about one third in advanced economies. - Since the mid-1990s, disposable-income inequality has increased more than market-income inequality due to reduced generosity of redistributive social benefits and diminished progressivity of income taxes. - Tax-side recommendations include: reduce opportunities for tax avoidance and evasion; consider raising average and marginal tax rates in economies with relatively low rates; increase top marginal income tax rates applied to the richest one-percent may require greater international cooperation; short-term resource mobilization should focus on broadening income and consumption tax bases by reducing exemptions, closing loopholes, and improving tax compliance; expand corporate and personal income tax bases; expand consumption tax base while designing to mitigate adverse distributional impacts. - Expenditure-side recommendations include: avoid continued decline in the most redistributive cash and in-kind transfers; enhance redistributive impact of transfers through means-tested and in-work benefits while recognizing potential work disincentives; rely more on targeted social expenditures; eliminate fiscally costly and inefficient universal price subsidies; expand conditional cash transfer programs; broaden coverage of public pension systems or consider targeted social pensions where constrained. - Enhancing fiscal capacity in developing economies: strengthen resource mobilization capacity and capacity to use more progressive tax and spending instruments; raise tax revenues and spend them more efficiently and equitably. ### Appendix 1. Construction of the International Gini Database — key details - Database coverage: - Covers 150 advanced and developing economies. - Gini estimates reported for 5-year windows, starting in 1980 and ending in 2010. - The constructed Gini database is unbalanced: Ginis do not exist for all economies over all years. - For advanced, emerging Europe, and Latin America and the Caribbean economies, Gini coefficients are based on disposable per capita income data. - For the majority of other economies, estimates are based on per capita consumption or expenditures. - All estimates reported are drawn from household surveys. - Estimates for any one country are always for a single base; income, consumption and expenditure inequality are never mixed for a single country. - Data sources and priority rules: - Five data sources used: EU-SILC, LIS, OECD, SEDLAC, World Bank WDI. - Priority given to reporting estimates based on disposable income; otherwise estimates based on consumption or expenditure are used. - For the majority of economies, a single data source is used for different years. - Where the "Source" column indicates two sources, this reflects Gini estimates being drawn from separate sources for different years to allow coverage of more recent years. - Method for combining sources and extending series: - Example for advanced economies: LIS is the main source for most advanced economies; LIS only goes up to 2007. To obtain Ginis for more recent years, the absolute changes in the disposable income Gini coefficient according to EU-SILC (which only starts around 2006) are added to the Gini for 2007 from LIS. - Validation tests were carried out to ensure comparability in the underlying data sources; tests show that both the level and changes in Ginis in both databases are highly correlated. - Construction of 5-year window values: - Reporting rule for each reference year (e.g., 1990 or 1995): If the Gini for the reference year is available it is reported. Otherwise the reported Gini is based on the nearest year (first below then above) to the reference year if available. Otherwise it is based on the second years below or above. *Source: _sdn1208rev - Executive Summary* ### Executive Summary ...................................................................................................... ### _sdn1208rev - Executive Summary ### Key findings on income inequality trends - Income inequality has increased in most advanced and many developing economies over recent decades, reflecting factors including globalization and technological change. - Large variation exists in average disposable (post-tax-and-transfer) income inequality across regions, much of which can be accounted for by differences in the level and progressivity of tax and spending policies. - Between 1990 and 2005, average inequality in each region changed by less than 4.5 percentage points. - Regional averages in 1990–2005: - The two most unequal regions (Sub-Saharan Africa and Latin America) had average Gini coefficients that exceeded 0.45 every year. - The two most equal regions (emerging Europe and advanced economies) had average Gini coefficients less than 0.34, a difference of 11 percentage points. - Over the last three decades, pre-tax-and-transfer (market income) shares of the richest increased substantially in English-speaking advanced economies, India, and China, but much less in Southern European and Nordic economies, and hardly at all in continental Europe and Japan. - United States specific figures cited: - Share of market income captured by the richest 10 percent rose from around 30 percent in 1980 to 48 percent by 2008. - Share of the richest 1 percent increased from 8 percent to 18 percent. - Share of the richest 0.1 percent increased from 2.6 percent to 10.4 percent. - The international dataset assembled covers 22 advanced and 128 developing economies. ### Fiscal policy’s redistributive role: overall assessment - Fiscal policy influences income distribution directly (current disposable incomes) and indirectly (future earnings capacities affecting market incomes). - There is a trade-off: redistributive tax-benefit systems can introduce economic inefficiencies as behavioral responses reduce the overall size of the income pool being redistributed. The efficiency cost of redistribution typically increases with the extent of redistribution. - The note focuses on the actual (observed) redistributive impact of fiscal policy (statutory incidence, as commonly used in the literature), recognizing that actual incidence can differ from statutory incidence. ### Advanced economies: evidence on redistribution - Fiscal policy has played a significant role in reducing income inequality in advanced economies, especially where pre-tax-and-transfer inequality was high. - Between 1985 and 2005, fiscal policy (direct income taxes and transfers) decreased the average Gini in 25 OECD countries by about one-third, that is, by around 15 percentage points. - 2005 examples: - Fiscal policy reduced income inequality by around 20 or more points in: Belgium, Denmark, Germany, Italy, Luxembourg, Poland, and the Slovak Republic. - Fiscal policy reduced income inequality by less than 10 points in: Korea, Iceland, Ireland, Switzerland, and the United States. - Composition of redistribution: - On average, redistribution achieved by public cash transfers is twice as large as that achieved through taxes. - Non-means-tested transfers (including public pensions and universal child benefits) account for the bulk of redistribution on the expenditure side; particularly important in Nordic economies, Austria, Belgium, Poland, and Hungary. - Income taxes achieve the greatest amount of redistribution on the tax side; in most economies, income taxes redistribute more than means-tested transfers. - United Kingdom and Ireland are exceptions where means-tested benefits are responsible for most of redistribution. - United States is an exception where taxes are more redistributive than transfers and where the income tax system plays a relatively strong role in redistributing towards low-income families. - Redistributive impact has declined since the mid-1990s: - Between the mid-1980s and mid-1990s, the Gini for market income increased by 3 percentage points, while the Gini for disposable income increased by only 0.8 points—implying offsetting fiscal redistribution increased in that earlier period. - Reforms since the mid-1990s have lessened the generosity of social benefits and the progressivity of income tax systems in advanced economies, making fiscal policy less redistributive. ### Developing economies: fiscal capacity and constraints - Fiscal policy’s redistributive impact is relatively low in many developing economies. - Enhancing distributive impact in developing economies requires improving capacity to raise tax revenues and to spend those resources more efficiently and equitably. ### Policy recommendations for distributive fiscal strategies (especially under fiscal consolidation) - In the context of fiscal consolidation, tax and spending measures should enhance or maintain the distributive effects of fiscal policy while supporting economic efficiency. Suggested measures include: - Reducing opportunities for tax evasion and avoidance. - Increasing the progressivity of income taxes over higher income brackets. - Cutting unproductive expenditures. - Expanding means-tested programs. - For developing economies, resource mobilization and expenditure reforms should focus on: - Broadening income and consumption tax bases. - Expanding corporate and personal income taxes by reducing tax exemptions and improving compliance. - Reducing universal price subsidies. - Improving capacity to implement better-targeted transfers. - Gradually expanding social insurance systems. ### Crisis and post-crisis distributional dynamics - No uniform pattern in distributional changes following the 2007–2008 financial crisis; effects varied across countries and over time: - Ireland: inequality initially declined early in the crisis due to a large fall in top incomes, increases in taxes, and expansion of redistributive social transfers; as the crisis deepened and fiscal consolidation intensified, inequality began to increase, with the Gini increasing by nearly 2 percentage points by end-2010. - Italy: Gini increased by 1 percentage point initially, then showed a decrease as the crisis evolved. - Other heterogeneous outcomes: Gini increased in Latvia and Lithuania but fell in Estonia, Greece, and Iceland; Gini increased in France and Spain but fell in Portugal and the Netherlands. - United States: Gini changed little during the crisis as expansion of public transfers offset high unemployment’s inequality impact. - Distributional effects of crises can take many years to fully materialize. ### Data and scope notes - The paper assembles an international Gini database; Appendix 1 documents its construction. - This document is a revised version of SDN/12/08 (published on June 28, 2012), incorporating updated data on international Gini coefficients. Figure 1, Table 1, and Appendix Table 1 were updated to include the new data. *Source: _sdn1208rev - Executive Summary* ### 2.2 percentage points, from 9.5 in the mid-1980s to 11.7 in the mid-1990s. As a result, fiscal ### _sdn1208rev - 2.2 percentage points, from 9.5 in the mid-1980s to 11.7 in the mid-1990s. As a result, fiscal ### Redistributive impact over time - Fiscal policy offset 73 percent of the 3 percentage-point increase in market income inequality between the mid-1980s and mid-1990s. - Between the mid-1980s and the mid-2000s, fiscal policy offset 53 percent of the increase in market income inequality. - Market income inequality grew by twice as much as redistribution over the two decades from the mid-1980s to the mid-2000s. - The fall in redistributive impact reflected reforms that reduced the overall progressivity of the tax-benefit system, including reductions in the generosity of social benefits (particularly unemployment and social assistance) and reductions in income tax rates, especially at higher income levels (OECD, 2011a). ### Fiscal design and the equity-efficiency trade-off - A key fiscal policy challenge is balancing redistributive and efficiency objectives; improved design can reduce the equity-efficiency trade-off. - Means-tested social benefits (benefits withdrawn as earnings increase) create disincentives for low-skilled workers to take up employment (OECD, 2011b). - Immervoll and others (2007) find that transferring an additional euro from high- to low-income individuals through traditional means-tested transfer programs results in a reduction in the welfare of high-income individuals by 2 to 4 euros in most economies. - Policy responses to reduce disincentives: - Introduction of in-kind benefits that link receipt of benefits to employment. - Expansion of active labor market programs and tightening rules for continued eligibility for unemployment benefits (more intensive job search requirements and participation in training). - Note: Designing and implementing these policies requires substantial administrative capacity. - Progressive income tax schedules can have disincentive effects among higher income groups; reductions in top income tax rates in many economies during the 1980s were followed by relatively high income growth at the top of the income distribution (Saez, 2004; Atkinson and Leigh, 2010; Roine, Vlachos, and Waldenstrom, 2009). - Countervailing research: - Piketty, Saez, and Stantcheva (2011) argue that the absence of any correlation between rising top incomes and per capita GDP growth indicates top income increases primarily reflect rent-seeking rather than productivity increases, motivating calls for more progressive taxation of higher income groups (Tanzi, 2011). - Need to remove opportunities for tax evasion and avoidance, which are typically greater for higher income groups, to preserve revenue potential and redistributive impact (Gruber and Saez, 2002). ### Indirect taxes and in-kind transfers - Indirect taxes tend to increase inequality; in-kind transfers are highly redistributive. - Indirect taxes: - In an analysis of 12 European Union economies, the effective indirect tax rate (share of consumption taxes in total household income) is on average three times higher for the bottom income decile than for the top decile (O’Donoaghue, Baldini and Mantovani, 2004). - Both the value-added tax (VAT) and excise duties are regressive in all economies; excise taxes are especially regressive, their share in total income being four times higher in the bottom income decile than in the top income decile. - In-kind transfers: - A high share of public spending is allocated to education, health care, housing, and food transfers (Garfinkel, Rainwater, and Smeeding, 2006; Brandolini and Smeeding, 2009; Aaberge and others, 2010). - Each component tends to reduce inequality: public housing benefits target low-income households; public education and health services are disproportionately used by households with children and elderly concentrated in lower parts of the disposable income distribution. - On average, in-kind transfers decreased the Gini coefficient by 5.8 percentage points in five European economies (Belgium, Germany, Greece, Italy, and the United Kingdom), with health accounting for 3.6 points and education for 2.2 points of this impact (Paulus, Sutherland, and Tsakloglou, 2009). ### Corporate tax incidence - Few incidence studies include corporate income taxes due to difficulty in establishing incidence. - The long-run incidence of corporate taxes on wages and capital depends on the relative mobility of capital and labor and the size of the home country in affecting the international rate of return on capital (Auerbach, 2006). - Taxation of rents (above normal profits) is likely to fall on owners of capital. - Recent empirical evidence suggests that between 45 and 75 percent of the corporate tax burden falls on wages (Gentry, 2007; Arulampalam, Devereux and Maffini, 2010). - Since wage earners typically have lower mean incomes than those with capital income, corporate income taxes may not be as progressive as they first appear; progressivity could be higher if low-skilled labor is a good substitute for capital. ### Developing economies: constraints on redistribution - Redistributive impact of fiscal policy in developing economies is severely restricted by lower overall levels of taxes and transfers. - Average tax ratios: - Advanced economies: exceed 30 percent of GDP. - Developing economies (excluding emerging Europe): generally fall in the range 15–20 percent of GDP. - Spending is substantially lower in developing economies, especially in Asia and the Pacific and in Sub-Saharan Africa; low transfer spending explains most of the difference. - This substantially reduces the redistributive potential of fiscal policy in developing economies. - Example: Almost three-quarters of the difference in disposable income inequality between Latin American economies and advanced economies can be explained by fiscal policy (Box 1). *Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/ft/sdn/2012/_sdn1208rev.pdf* ### Box 1. Fiscal Policy and Income Inequality in Latin America ### Box 1. Fiscal Policy and Income Inequality in Latin America ### Fiscal policy effectiveness: key findings - In the mid-2000s, the tax and transfer system decreased the average Gini (the difference between the Ginis for market and disposable incomes) in six Latin American economies (Argentina, Brazil, Chile, Colombia, Mexico, and Peru) by only about 2 percentage points, from 0.52 to 0.50. - Similar magnitudes are reported by Lustig and others (2011) using more recent data. - By contrast, in 15 European economies the tax and transfer system decreased the Gini by around 20 percentage points, from 0.46 to 0.27. - Almost three-quarters of the difference in the Ginis for disposable income between these Latin America and European countries (18 out of the 23 points) can be explained by different fiscal policies. ### Reasons for limited redistributive impact in Latin America - Low overall tax and spending levels and a less progressive tax and spending mix: - Tax collections in the region are below the levels achieved in economies with similar levels of income, with the median being 4 percentage points lower. - Recent increases in the tax-to-GDP ratio have relied more on regressive indirect taxes and a decreasing share of more progressive income taxation. - The low tax ratio reflects narrow tax bases (due to tax evasion, numerous loopholes, a large informal sector and weak tax administrations) rather than low tax rates. - Social spending differences: - The six Latin American economies above spend 7.6 percent of GDP on social transfers compared to 16.3 percent in the 15 European economies. - In Latin America, the richest 40 percent of the income distribution capture over 70 percent of social spending, whereas social spending in Europe is distributed evenly across the income distribution. ### Distributional effects by instrument - Indirect taxes: - Greater reliance on indirect taxes and narrower tax bases limits redistributive potential. - Taxes on imports are often among the most regressive; excise taxes (fuel, alcohol, tobacco) tend to be progressive. - Exemption of small businesses (including agriculture and the informal sector) can result in a progressive incidence for value-added taxes. - Direct taxes: - Personal income and property taxes are generally progressive in developing economies. - High tax noncompliance and narrow bases (widespread exemptions, preferential treatment of capital and other income) lead to low income tax ratios, low income tax progressivity, and overall regressivity. - Resource taxation can be progressive and efficient but is applied mostly to foreign incomes. - Expenditures and in-kind spending: - Low spending and poor targeting limit the redistributive capacity of transfer programs; large informal sectors complicate program design. - Participation in social insurance is often restricted to high-income formal workers and public-sector employees; in the early 2000s, the share of the population above legal retirement age in receipt of a pension in developing economies was, on average, around 40 percent, as compared to 90 percent in European economies. - Aggregate education and health spending is regressive in many developing economies; primary care and primary education can be progressive but are dominated by regressivity at higher levels. ### Conditional cash transfer (CCT) programs - CCTs target income transfers to poor households conditional on investments in education and health. - 17 Latin American economies are currently operating conditional cash transfer programs, with program expenditures typically falling below 1 percent of GDP. - The largest programs, in Brazil and Mexico, have been estimated to reduce the Gini for disposable income by 2.7 percentage points, accounting for about a fifth of the decrease in the Gini coefficient between the mid-1990s and the mid-2000s. - CCTs are most cost-effective when targeted at the poorest households; expansions must be designed to generate human capital impacts and avoid labor supply disincentives. ### Fiscal consolidation and inequality: mechanisms - Short-run macroeconomic channel: - Consolidation reduces output and increases unemployment in the short run, typically associated with a declining wage share, which tends to increase inequality. - Increasing unemployment widens wage inequality as low-wage workers are hit harder. - Policy composition channel: - Income inequality will tend to increase more when adjustment relies on increasing regressive taxes (such as consumption taxes) or cut-backs in progressive spending. - Definition of a large fiscal consolidation: - Lasts at least three years, where the cyclically adjusted primary balance (CAPB) improves by at least 5 percent of GDP, and where the cumulative change in the CAPB is not reversed by more than 1 percentage point from one year to the next. ### Advanced economies: evidence and policy lessons - Episodes of large fiscal adjustment in advanced economies have been associated with sizeable increases in unemployment in the short term. - The distributive impact in the short term depends on the size of automatic stabilizers, whether they operate, and how quickly exports and private demand respond. - Increased expenditures on unemployment benefits help contain widening income inequality by cushioning demand and replacing lost wage incomes. - Cut-backs in government services can worsen income distribution given low-income households’ reliance on these services. - Mix of measures matters: - Adjustments biased toward expenditure cuts have tended to exacerbate income inequality. - Protecting progressive social benefits and improving targeting can minimize adverse distributional impacts (illustrated by Denmark, Germany, Iceland, Sweden). - Policy options to preserve equity while consolidating: - Greater reliance on progressive revenue measures where feasible. - Removing opportunities for tax avoidance and evasion. - Greater reliance on progressive wealth and property taxes. - Broadening expenditure reforms (military spending, subsidies, public-sector wages). - Expanding active labor market programs (job-search support, targeted wage subsidies, training). ### Developing economies: evidence and policy lessons - Large fiscal adjustments have had relatively significant impacts on the real economy and unemployment; however, the increase in unemployment has generally been of shorter duration due to shorter consolidation episodes. - Consolidation can be essential to reduce high inflation, which typically has adverse effects on inequality. - Consolidation effects can improve equity if: - Expenditure reductions are concentrated in non-progressive spending. - Social safety nets are strengthened to protect vulnerable households during adjustment. - Revenue measures will often be needed; adverse distributional impacts of tax increases can be mitigated by reforms enhancing tax efficiency and equity (greater reliance on progressive income taxation, removal of avoidance/evasion opportunities). ### Summary conclusions and policy recommendations - Historical role of fiscal policy: - Fiscal policy has played a key role in reducing income inequality in advanced economies, with the combination of progressive income taxes and redistributive transfers decreasing inequality by about one third. - Since the mid-1990s, disposable-income inequality has increased more than market-income inequality due to reduced generosity of redistributive social benefits and diminished progressivity of income taxes. - Tax-side recommendations: - Reduce opportunities for tax avoidance and evasion, which disproportionately benefit top incomes. - Consider raising average and marginal tax rates in economies with relatively low rates, where feasible. - Increasing top marginal income tax rates applied to the richest one-percent of the population may require greater international cooperation to be effective. - Short-term resource mobilization should focus on broadening income and consumption tax bases by reducing exemptions, closing loopholes, and improving tax compliance. - Expand corporate and personal income tax bases; expand consumption tax base (e.g., broader VAT adoption) while designing consumption taxes to mitigate adverse distributional impacts (appropriate treatment of small businesses, excises on luxury goods). - Expenditure-side recommendations: - Avoid continued decline in the most redistributive cash and in-kind transfers. - Enhance redistributive impact of transfers through means-tested and in-work benefits while recognizing potential work disincentives. - Rely more on targeted social expenditures to protect households from poverty and improve education and health outcomes among disadvantaged households. - Eliminate fiscally costly and inefficient universal price subsidies (including tax expenditures) to generate resources. - Expand conditional cash transfer programs as part of social protection strategies. - Broaden coverage of public pension systems; where constrained, consider targeted social pensions. - Short- and medium-term strategy for advanced economies undergoing consolidation: - Short term: protect the most redistributive social benefits (including unemployment benefits) until recovery and unemployment decline; expand active labor market programs. - Medium term: rely somewhat more on tax measures and broaden coverage of expenditure reforms (military spending, subsidies) to avoid large cuts in redistributive transfers. - Enhancing fiscal capacity in developing economies: - Strengthen resource mobilization capacity and capacity to use more progressive tax and spending instruments. - Raise tax revenues and spend them more efficiently and equitably to address higher income inequality relative to advanced economies. *Source: Box 1. Fiscal Policy and Income Inequality in Latin America, _sdn1208rev.* ### Appendix 1. Construction of the International Gini Database ### Appendix 1. Construction of the International Gini Database ### Database coverage - Covers 150 advanced and developing economies. - Gini estimates reported for 5-year windows, starting in 1980 and ending in 2010. - The constructed Gini database is unbalanced: Ginis do not exist for all economies over all years. - For advanced, emerging Europe, and Latin America and the Caribbean economies, Gini coefficients are based on disposable per capita income data. - For the majority of other economies, estimates are based on per capita consumption or expenditures. - All estimates reported are drawn from household surveys. - Estimates for any one country are always for a single base; income, consumption and expenditure inequality are never mixed for a single country. ### Data sources and priority rules - Five data sources used: - European Union Statistics on Income and Living Conditions (EU-SILC) - Luxembourg Income Study (LIS) - Organisation for Economic Cooperation and Development (OECD) - Socio-Economic Database for Latin America and the Caribbean (SEDLAC) - World Bank, World Development Indicators (WDI) - Priority given to reporting estimates based on disposable income; otherwise estimates based on consumption or expenditure are used. - For the majority of economies, a single data source is used for different years. - Where the "Source" column indicates two sources, this reflects Gini estimates being drawn from separate sources for different years to allow coverage of more recent years. ### Method for combining sources and extending series - Example procedure used for advanced economies: - LIS is the main source for most advanced economies. - LIS only goes up to 2007. - To obtain Ginis for more recent years, the absolute changes in the disposable income Gini coefficient according to EU-SILC (which only starts around 2006) are added to the Gini for 2007 from LIS. - Validation tests were carried out to ensure comparability in the underlying data sources. - Tests show that both the level and changes in Ginis in both databases are highly correlated. ### Construction of 5-year window values - Reporting rule for each reference year (e.g., 1990 or 1995): - If the Gini for the reference year is available it is reported. - Otherwise the reported Gini is based on the nearest year (first below then above) to the reference year if available. - Otherwise it is based on the second years below or above. *Source: Appendix 1. Construction of the International Gini Database (IMF).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/ft/sdn/2012/_sdn1208rev.pdf_